Re-discovering Measurement
3. Innovations in value and performance measurement
3.1 Five categories
(47) Over the past decade, there has been an astonishing amount of activity by innovators
attempting to measure value and performance beyond the boundaries of traditional accounting. Over "100" value and performance
measurement approaches have emerged, many of which are identified in Appendix A to this paper. For purposes of
this discussion, we can group these new measurement approaches into the following five categories.
|
Focus
|
Value and Performance Measurement Innovations |
| Intangibles |
Indicators |
Market Cap |
The"Capitals" |
Value Streams |
| Selected examples |
- FASB's Intangibles Project - Value dynamics - Brookings Report |
- Balanced scorecard - KPI's |
- Market Cap - Book Value Gap Analysis - Economic Value-based analysis |
- Intellectual Capital - Human Capital - Societal Capital |
- Intangibles value streams - Event-based enterprise value streams |
| How the innovators define the problem |
- Intangibles not fully reflected in financial statements - Gap between market and book value |
- Accounting measurement is not sufficient basis for strategic management of enterprise |
- Enterprises are not managing gap between book (current operation) and market value |
- Enterprise are not managing major components of "capital" that account for the majority of enterprise value |
- Traditional transaction-based (value realization) accounting provides no insight into performance of organization in creating value |
How the innovators describe the solution |
- Measure and disclose fair value of intangible assets |
- Set goals and track performance using a broad framework of metrics |
- Decompose market cap into current and future growth value components, and create system for tracking drivers of future growth |
- Frameworks and systems for measuring customer, human, structural, and other "capitals" |
- Parallel value creation measurement system that models the potential of future value streams and tracks performance in realizing it |
(48) People advocating approaches in the "Intangibles" category tend to focus on extending traditional
techniques for measuring the value of tangible assets to the world of intangibles.
(49) Those working on "Indicators" tend to focus on constructing a framework of metrics that extends
beyond traditional accounting measurement.
(50) The proponents of "Market Cap" approaches base their analysis on decomposing and/or influencing
the market price of a company's shares.
(51) The adherents of approaches in the Capitals category argue that the best way to build the
financial capital of an enterprise is to focus attention on the interrelationships among customer capital, structural
capital, intellectual capital, and the other "capitals".
(52) The Value Streamers argue that rather than focus on the traditional concept of an "asset",
we can directly model the value creation potential of value streams, and the interactions among them, to create a
forward-looking system of value creation measurement.
3.2 Measurement versus disclosure
(53) It is important to note that in compiling the list of innovations categorized above, the
focus was solely on measurement, and not on corporate reporting or disclosure in general.
(54) Work is underway within and beyond the global accounting profession focused on enhanced disclosure
or reporting frameworks. To cite only a few examples, relevant projects include:
- the proposed Enhanced Business Reporting Consortium (EBRC) led by the American Institute of Certified
Public Accountants (AICPA);
- the "Information for Better Markets" campaign of the Institute of Chartered Accountants of England and Wales (ICAEW);
- work by the Canadian Institute of Chartered Accountants (CICA) on MD&A Guidelines, and an earlier project on
Total Value Creation;
- publications sponsored by major firms, such as Price Waterhouse Cooper's book "Value Reporting";
- exploration by various European institutes, the Global Reporting Initiative, and other international bodies
of ways to report on intellectual, human, societal, and other forms of capital, and on various dimensions of sustainability.
(55) In the context of these initiatives, what is meant by the term "reporting framework". The Enhanced Business
Reporting Consortium defines a reporting framework as:
-
"A framework to enhance information relevance and consistency. This information includes information about opportunities,
risks, strategies and plans, and about the quality, sustainability and variability of cash flows and earnings, as well as
industry-specific, process-oriented value drivers and key performance indicators. "
(56) A reporting or disclosure framework is evidently meant to convey something much broader
than "measurement". A reporting framework is intended to provide comprehensive guidelines concerning information
of all kinds that a company should make available to its stakeholders, addressing both what should be disclosed and
how. Only a subset of those disclosures are "measures".
3.3 Comparing measurement approaches: systems and frameworks
(57) In considering how alternative measurement approaches compare to each other and to traditional
accounting, we are confronted with the need to differentiate between measurement approaches that are systemic and those
that are not.
(58) Compare, for example, a traditional balance sheet and income statement, and a set of key
performance indicators. Both include quantitative measures, and to that extent are similar.
(59) But there are crucial differences. The numbers in the balance sheet and income statement
emerge from an accounting measurement system, in which the debits must match the credits. Any change to any number
in a set of financial statements requires a corresponding change in some other number.
(60) By contrast, a set of key performance indicators is generally not systemic, but rather,
constitutes what can be referred to as a measurement framework. In a framework of key performance indicators, there
is normally a logical relationship among the elements of the framework. However, the elements of a framework of key
performance indicators are not related to each other in the same systemic manner as are the elements in a set of financial
statements.
(61) For purposes of this discussion, we can differentiate between measurement systems and
measurement frameworks using the following criteria:
|
Measurement
System
|
Measurement
Framework
|
| Backed by an internally-consistent integrated "model" (a representation of reality)
Ability to link inputs and outputs through causal linkages
Constituent elements of model are non-arbitrary
Examples:
- Astronomical calculations
- Traditional double-entry accounting
|
Discrete, standalone (but may be organized in a logical framework)
Selection of elements of framework may be arbitrary
Examples:
- Political risk
assessment
- Key performance
indictors |
(62) Planetary mechanics is a good example of a measurement system. The motions of the planets
can be modeled with sufficient precision that it is possible to predict eclipses centuries into the future.
(63) Weather forecasting is a good example of a discipline which formerly was not systemic, but
has become so. The first weather instruments were invented about the same time as double-entry bookkeeping: the
hygrometer was invented around 1450, the thermometer in 1592 by Galileo, and the barometer in 1643. The effort
to make weather forecasting reliable began in the late 1800s. Vilhelm Bjerknes, a Norwegian, and Lewis Fry Richardson
of Britain are credited as pioneers in the attempt to model future weather through a system of mathematical equations.
In his first full-scale attempt, it took Richardson several months to do the calculations to support a six-hour forecast
for an area near Munich -- a forecast which was not only somewhat late to be a forecast, but was also wildly inaccurate
even in hindsight.
(64) Despite its lack of immediate success, Richardson's attempt set the course for innovation in
weather prediction. Now, just under a century later, satellites ring the globe providing thousands of real-time
weather observations, complex computer models produce detailed forecasts of weather at multiple levels in the
atmosphere, covering virtually all of the earth's surface, and aviators and sailors can download "grid charts"
from the internet providing an extraordinary amount of forecast data. Weather forecasting is not perfect: but it is systemic.
(65) This line of thinking leads to the question: Are any of the alternative value measurement
approaches in any of the five categories referred to in Section 3.1 "systemic", or do any have the potential to
become so with further development? This and other criteria are discussed in Section 5.
(66) This line of thinking also leads to the observation that the relationships among disclosure,
measurement, and systemic measurement can be depicted as follows:
(67) It is evident that any enhanced reporting or disclosure framework will include a combination
of measurement information that is systemic, as well as measurement information that is not systemic.
(68) This leads to the following question: What are the implications for users, producers, and
auditors of measurement information of combining systemic and non-systemic approaches within a broader reporting
or disclosure framework? This question is not specifically addressed in this paper. However, the analysis in
Sections 4 and 5 provides an initial foundation for addressing it.
3.4 A new value measurement paradigm?
(69) Virtually all of the approaches in each of the categories described in 3.1 above were
developed to meet the specific needs of decision-makers. In most cases, their practical utility for these purposes
has been demonstrated in many successful implementations.
(70) But there is a higher-level issue here. Many, if not most of these approaches were explicitly
developed in an attempt to overcome the limitations of traditional accounting. In the context of the argument in Section
2, it is logical to ask: to what extent did they succeed?
(71) In other words, do any of the approaches in the five categories represent the equivalent, in
relation to value and performance measurement, of Einstein's breakthrough on relativity? Or do they simply represent
incremental improvement on the status quo, but not a fundamental breakthrough? And how would we recognize the
difference? By what criteria could we assess the degree to which any of these value measurement approaches is,
or points toward, a new paradigm in value measurement? The next sections attempt to lay some of the necessary
groundwork for addressing these questions.
